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UPDATE 1-ECB set to cut interest rates to record low

Published 03/05/2009, 03:34 AM
Updated 03/05/2009, 03:40 AM
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(Updates with meeting started)

By Marc Jones

FRANKFURT, March 5 (Reuters) - The European Central Bank is expected to cut interest rates to an all-time low of 1.5 percent on Thursday and slash its 2009 and 2010 economic forecasts to reflect the break-neck pace of deterioration in the euro zone.

All 78 economists polled by Reuters see rates being cut to the lowest level in the ECB's 10-year history at its March policy meeting, following a pause at 2.0 percent in February.

A cut has been on the cards since January when President Jean-Claude Trichet described this meeting, which started at 0800 GMT, as an important "rendezvous" for ECB rate setters.

A steady stream of hints in the meantime has been enough to convince all but two experts polled to bet on another 50 basis point cut when its decision is announced at 1245 GMT.

The action is unlikely to stop there. Economists expect the ECB to renew its promise to support money markets through sickness and back into health.

There is also hope Trichet will use his news conference at 1330 GMT to hint that the ECB is closer to deciding on other ways to boost the struggling euro zone economy once it runs out of ammunition as interest rates head towards zero.

"We expect the ECB to cut rates by 50 basis points, like most people, but what will really be interesting is what Trichet says about potential non-conventional measures," said UBS economist Stephane Deo. "The question is what else they can do? They could buy paper on the market, they could intervene more on the money markets and there is talk about clearing houses for certain assets."

Policymakers Axel Weber and Christian Noyer said this week that the ECB is weighing up all options, including buying short-term commercial debt. Others, including George Provopoulos, Ewald Nowotny and Miguel Angel Fernandez Ordonez, have made similar comments but some analysts think Trichet will hold fire on the subject.

"I think it's still too early to say anything in terms of unconventional measures like asset purchases," said Citi economist Juergen Michels. "Especially when there is still some room to go with interest rates."

He also expected Trichet to refrain from giving too much away on interest rates. "I do not expect Trichet to give a strong hint that another rate move is on the way. I think he will leave it fairly open," he said.

LOW POINT

Another major point of debate for economists is how low the ECB is really prepared to go with rates. So far, policymakers have said they don't want follow the U.S. Federal Reserve and Bank of Japan and cut rates to the bone.

Weber, who heads the German Bundesbank, became the first to draw a line in the sand at 1 percent last week while Trichet has said that there would be a number of disadvantages if interest rates were at zero percent.

While the majority of economists agree with Weber, they remain split on the likely low point for ECB rates.

Some also argue the headline rate is no longer so important because the bank's deposit rate, which is 100 basis points lower, is steering the all-important money market rates that typically determine borrowing rates for consumers and businesses.

"Actually the main refi rate does not mean much. If you look at the very, very short end of the curve, the overnight rate is more aligned to the deposit rate than the refi rate," said UBS's Deo.

The unusual situation has come about because the ECB is lending banks unlimited amounts of euros at fixed interest rates as part of its plan to calm money markets.

PROJECTIONS

The ECB will also release its latest quarterly in-house economic forecasts.

Following dire economic data in recent weeks, which included confirmation of the worst quarter for euro zone gross domestic product (GDP) on record, economists expect heavy downward revisions compared with the last set in December.

Staff then forecast GDP ranging from no change to a 1.0 percent fall this year, and growth of between 0.5 and 1.5 percent next year.

But ECB Executive Board member Juergen Stark has said he expects the new forecasts, to be released during the news conference, to be in line with the latest IMF forecasts which see a 2 percent contraction this year.

Inflation projections are also expected to be cut. Last time staff saw inflation of 1.1 to 1.7 percent in 2009 and 1.5 to 2.1 percent in 2010. Analysts now expect it to average well under 1 percent this year and stay below the ECB's target of close to, but below, 2 percent in 2010. (Reporting by Marc Jones; Editing by Toby Chopra)

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